Investing can often be broken down into a few simple rules that
investors can follow to be successful. But success can be as much about
what to do as it is what not to do. On top of that, our emotions throw a
wrench into the whole process. While everyone knows you need to "buy
low and sell high," our temperament often leads us to selling low and
buying high.
So it's key to develop a set of "golden rules" to help guide you
through the tough times. Anyone can make money when the market is
rising. But when the market gets choppy, as it did in 2020, investors
who succeed and thrive are those who
have a long-term plan that works.
Rule No. 1 - Never lose money
Let's kick it off with some
timeless advice from legendary investor Warren Buffett,
who said "Rule No. 1 is never lose money. Rule No. 2 is never forget
Rule No. 1." The Oracle of Omaha's advice stresses the importance of
avoiding loss in your portfolio. When you have more money in your
portfolio, you can make more money on it. So a loss hurts your future
earning power.
Of course, it's easy to say not to lose money. What
Buffett's rule essentially means is don't become enchanted with an
investment's potential gains, but also look for its downsides. If you
don't get enough upside for the risks you're taking, the investment may
not be worth it. That's one reason many investors are avoiding long-term
bonds now. Focus on the downside first, counsels Buffett.
Rule No. 2 - Think like an owner
"Think
like an owner," says Chris Graff, co-chief investment officer at RMB
Capital. "Remember that you are investing in businesses, not just
stocks."
While many investors treat stocks like gambling, real
businesses stand behind those stocks. Stocks are a fractional ownership
interest in a business, and as the business performs well or poorly over
time, the company's stock is likely to follow the direction of its
profitability.
"Be aware of your motivation when investing," says
Christopher Mizer, CEO of Vivaris Capital in La Jolla, California. "Are
you investing or gambling? Investing involves an analysis of
fundamentals, valuation, and an opinion about how the business will
perform in the future."
"Make sure the management team is strong
and aligned with the interests of shareholders, and that the company is
in a strong financial and competitive position," says Graff.
Rule No. 3 - Stick to your process
"The
best investors develop a process that is consistent and successful over
many market cycles," says Sam Hendel, president of Levin Easterly
Partners. "Don't deviate from the tried and true, even if there are
short-term challenges that cause you to doubt yourself."
One of the best strategies for investors: a long-term buy-and-hold approach.
You can buy stock funds regularly in a 401(k),
for example, and then hold on for decades. But it can be easy when the
market gets volatile - as it did in 2020 - to deviate from your plan
because you're temporarily losing money. Don't do it.
Rule No. 4 - Buy when everyone is fearful
When
the market is down, investors often sell or simply quit paying
attention to it. But that's when the bargains are out in droves. It's
true: the stock market is the only market where the goods go on sale and
everyone is too afraid to buy. As Buffett has famously said, "Be
fearful when others are greedy, and greedy when others are fearful."
The good news if you're a
401(k)
investor is that once you set up your account you don't have to do
anything else to continue buying in. This structure keeps your emotions
out of the game.
Rule No. 5 - Keep your investing discipline
It's
important that investors continue to save over time, in rough climates
and good, even if they can put away only a little. By continuing to
invest regularly, you'll get in the habit of living below your means
even as you build up a nest egg of assets in your portfolio over time.
The
401(k) is an ideal vehicle for this discipline, because it takes money
from your paycheck automatically without you having to decide to do so.
It's also important to pick your investments skillfully -
here's how to select your 401(k) investments.
Rule No. 6 - Stay diversified
Keeping
your portfolio diversified is important for reducing risk. Having your
portfolio in only one or two stocks is unsafe, no matter how well
they've performed for you. So experts advise spreading your investments
around in a diversified portfolio.
"If I had to choose one strategy to keep in mind when investing,
it would be diversification,"
says Mindy Yu, director of investments at Stash. "Diversification can
help you better weather the stock market's ups and downs."
Rule No. 7 - Avoid timing the market
Experts
routinely advise clients to avoid trying to time the market, that is,
trying to buy or sell at the right time, as is popularized in TV and
films. Rather they routinely reference the saying "Time in the market is
more important than timing the market." The idea here is that you need
to stay invested to get strong returns and avoid jumping in and out of
the market.
And that's what Veronica Willis, an investment
strategy analyst at Wells Fargo Investment Institute recommends: "The
best and worst days are typically close together and occur when markets
are at their most volatile, during a bear market or economic recession.
An investor would need expert precision to be in the market one day, out
of the market the next day and back in the following day."
Rule No. 8 - Understand everything you invest in
"Don’t
invest in a product you don’t understand and ensure the risks have been
clearly disclosed to you before investing," says Chris Rawley, founder
and CEO at Harvest Returns, a fintech marketplace for investing in
agriculture.
Whatever you're investing in, you need to understand
how it works. If you're buying a stock, you need to know why it makes
sense to do so and when the stock is likely to profit. If you're buying a
fund, you want to understand its track record and costs, among other
things. If you're buying an annuity, it's vital to understand
how the annuity works and what your rights are.
Rule No. 9 - Review your investing plan regularly
While
it can be a good idea to set up a solid investing plan and then only
tinker with it, it's advisable to review your plan regularly to see if
it still fits your needs. You could do this whenever you check your
accounts for tax purposes.
"Remember, though, your first financial
plan won’t be your last," says Kevin Driscoll, vice president of
advisory services at Navy Federal Financial Group in the Pensacola area.
"You can take a look at your plan and should review it at least
annually - particularly when you reach milestones like starting a
family, moving, or changing jobs."
Rule No. 10 - Stay in the game, have an emergency fund
It's
absolutely vital that you have an emergency fund, not only to tide you
over during a tough time, but also so that you can stay invested long
term.
"Keep 5 percent of your assets in cash, because challenges
happen in life," says Craig Kirsner, president of retirement planning
services at Stuart Estate Planning Wealth Advisors in Pompano Beach,
Florida. He adds: "It makes sense to have at least six months of
expenses in your savings account."
If you have to sell some of
your investments during a rough spot, it's often likely to be when they
are down. So with an emergency fund you're actually able to stay in the
investing game longer. Money that you might need in the short term (less
than three years) needs to stay in cash,
ideally in an online savings account or
perhaps in a CD, and shop around to get the best deal.
Bottom line
Investing
well is about doing the right things as much as it is about avoiding
the wrong things. And amid all of that, it's important to manage your
temperament so that you're able to motivate yourself to do the right
things even as they may feel risky or unsafe.
